Debt Collateralization, Capital Structure, and Maximal Leverage

Feixue Gong and Gregory Phelan
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Feixue Gong: Massachusetts Institute of Technology

No 2015-13, Department of Economics Working Papers from Department of Economics, Williams College

Abstract: We study how allowing agents to use debt as collateral affects asset prices, leverage, and interest rates in a general equilibrium, heterogeneous-agent model with collateralized financial contracts and multiple states of uncertainty. In the absence of debt collateralization, multiple contracts are traded in equilibrium, with some agents borrowing using risky debt and others borrowing with risk-free debt. When agents can use debt contracts as collateral to borrow from other agents, margin requirements decrease, asset prices increase, and the interest rate on risky debt decreases. We characterize equilibrium for N states and L levels of debt collateralization and prove that enough levels of debt collateralization creates an equilibrium featuring maximal leverage on all debt contracts. In the dynamic model, debt collateralization creates larger asset price volatility.

Keywords: Leverage; margins; asset prices; default; securitized markets; asset-backed securities; collateralized debt obligations (search for similar items in EconPapers)
JEL-codes: D52 D53 G11 G12 (search for similar items in EconPapers)
Pages: 59 pages
Date: 2015-07, Revised 2016-07
New Economics Papers: this item is included in nep-ban
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Debt collateralization, capital structure, and maximal leverage (2020)
Working Paper: Debt Collateralization, Capital Structure, and Maximal Leverage (2019)
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